World

Israeli exporters weigh options as shekel strength persists

JERUSALEM (Reuters) - Arie Levin envisions a time in the not too distant future where his micro electronics company, AVX Corp, may no longer have operations in Israel.

Due to a sharp appreciation of the shekel against the dollar, AVX, which was founded in 1972 and makes components for wireless products, has already shifted some of its thin film production from Jerusalem to the Czech Republic.

"The deterioration of the value of the dollar versus the shekel has contributed to a 20 percent increase in our costs, which narrows down the profit margins and forces us to look for other solutions," said Levin, head of AVX Israel, which is 70 percent owned by Kyocera.

"I now have more Czech employees than Israeli," he said, noting his Israeli workforce has shrunk to 250 from 600, with many of the layoffs coming in the past year as the shekel appreciated.

"If nothing changes, I envision I will be under pressure to move more and more and that is the last thing I would like to do."

The shekel stands at 3.47 per dollar, near its strongest level since August 2011. It has appreciated 15 percent against the dollar over the past year and a half, making it among the world's strongest currencies and hurting Israeli exporters.

With exports making up as much as 40 percent of economic activity, exporters have been vocal about their diminishing competitiveness, especially as it has coincided with a spike in salaries, food, fuel electricity and petrol prices and other living costs, and economic weakness in Europe and the United States, Israel's two largest trading partners. The strong shekel has also made imports cheaper, adding to local producers' woes.

Many firms accuse the Bank of Israel and government of doing little while their profits shrink and factory job growth has been frozen the past two years. Companies say they are surviving by buying supplies abroad, cutting back on certain products for export and trimming other costs.

"The price you got two years ago in U.S. dollars is not enough today. It's almost losing money," said Sam Donnerstein, chief executive of security door maker Rav Bariach.

TRANSITION

Analysts believe Israel's economy is going through a transition since the discovery of two huge offshore natural gas wells. Tamar started production a year ago, and the larger Leviathan is slated to come on line in 2016 or 2017, with 40 percent of reserves earmarked for export.

"Natural gas is going to be the driver of the economy," said Bank Leumi chief economist Gil Bufman. "The export sector is paying the price of the strong shekel, which is in part due to natural gas."

Prior to the global financial crisis, exports rose by around 10 percent a year but Bufman doubts they will grow by double digits again - even when the global economy recovers. Exports fell 0.1 percent in 2013 after a 0.9 percent rise in 2012.

"It's a long-term process but it has been showing up clearly in the data the last few years," Bufman said. "Something structural has changed in the economy and export element."

The Manufacturers' Association estimates that nearly 30 percent of medium and larger manufacturers now have production lines abroad, up from 16 percent a decade ago.

At the same time, exporters are projected to lose about $4 billion in 2014 - $3 billion in export deals which could have been won if a better price had been given and another $1 billion in local sales because imports have become cheaper.

That will result in 8,000 fewer new jobs, the group said, noting that sales of textiles, rubber, plastic, machinery, medicines, wood, paper and electrical equipment from local firms have slid between 6 and 20 percent over the past 5 years.

"It is really bad," said Amir Hayek, the association's chief executive. "If the situation continues, manufacturers will have no choice but to move near customers or raw materials."

GAS BOOST

The shekel has been underpinned by the start to natural gas production at Tamar a year ago. With fuel imports sharply lower, it boosted Israel's current account in the balance of payments to $7.2 billion in 2013 from $800 million in 2012.

The Bank of Israel set up a programme to offset the gas impact on the current account, buying $2.5 billion of foreign exchange in 2013 with plans for another $3.5 billion this year.

The government has also established a sovereign wealth fund to prevent the so-called Dutch Disease, whereby a sudden explosion in national wealth overheats the economy and undermines exports - but its impact has yet to be felt.

In addition, the central bank has been buying foreign currency outside of the natural gas programme when it believes the currency is not reacting to fundamentals. Since 2008, it has bought about $55 billion of foreign currency - mostly dollars - with $2.1 billion purchased in the first two months of 2014.

Its total of $84 billion of foreign currency reserves is even higher than that of Britain, and the central bank contends that without the purchases, the shekel would be even stronger.

Interest rates have also been lowered to narrow the gap with other countries. The benchmark rate was reduced to 0.75 percent - its lowest level since November 2009 - from one percent in February, the fourth such move since the start of 2013.

While the Bank of Israel prefers a weaker shekel to help exports, it understands its reach is limited since a large part of the currency's strength has been economic growth that has outpaced the rest of the West and large foreign capital inflows partly fuelled by the purchase of Israeli high-tech firms.

Despite a scant rise in exports, Israel's economy grew 3.3 percent in 2013, helped by gas production, compared with average growth of 1.2 percent for OECD countries. The Bank of Israel expects 3.1 percent in 2014 and 3 percent in 2015, although on a per capita basis the rates are far lower due to Israel's annual population growth of nearly 2 percent.

Karnit Flug, Israel's central bank chief, believes exporters must learn to live with a strong shekel.

"The more basic industries obviously have a harder time competing given the more appreciated exchange rate, and therefore, they really need to adjust and improve their ability to compete," Flug told Reuters.

She said most of Israel's exports are concentrated in the high-tech sector and can compete despite the stronger shekel.

"The appreciation of the exchange rate, most of it is actually coming from the fact that the economy is doing relatively well," Flug said.

"It's related to fundamentals. It's related to the fact we have a current account surplus and we have substantial FDI (foreign direct investment) so these are part of the positive aspects of the economy, which leads to the appreciation. Some industries will definitely have to adjust," she said.

STAYING PUT

According to the Israel Export & International Cooperation Institute, there are more than 4,000 export companies in Israel.

For now, most are staying put, hoping that the Bank of Israel's actions ultimately lead to a weaker shekel.

The government has vowed to help exporters but so far action has been mainly in the form of the Finance Ministry hedging some of its dollar-denominated debt by buying dollar forward contracts while the finance and economy ministries pushed through an aid package for exporters that includes an insurance boost.

"What we need to do is help exporters be more competitive and create more incentives to invest more in research and development," said Morris Dorfman, deputy head of the National Economic Council in the Prime Minister's Office.

Hayek, the Manufacturers' Association chief, believes that for manufacturers to survive in the long term, a dollar-shekel rate of 3.80 is required, or a depreciation of 10 percent from current levels.

He and others have urged the Bank of Israel to support a floor for the exchange rate, although the bank has so far nixed the idea. Zvi Eckstein, a former Bank of Israel deputy governor, said a floor should be set around 3.3-3.4 shekels per dollar.

"Everyone would agree that below 3.6 or 3.5 is out of the medium term equilibrium," he said. "Once you set a limit to the strength of the shekel and the exchange rate is around that level for a while then it limits the ability of speculators to make money."

Bank Hapoalim chief economist Leo Leiderman said a floor would benefit only speculators and that encouraging efficiency and productivity would be the best way to help exporters.

"Attractive countries go together with stronger currencies," Leiderman said. "The lesson learned is central banks shouldn't go against the general trend of the exchange rate."